For weeks it has been clear that any agreement on student loans would do little for low-income undergraduates, whose interest rate on new loans doubled on July 1st to 6.8 percent. At first, Democrats rallied around extending their subsidy, arguing that another year was necessary to put together a more comprehensive solution. But their position was undermined from the very beginning by President Obama, who put forward a “market-based” plan not unlike those proposed by Republicans, which would peg interest rates to the yield on 10-year Treasury notes, plus an additional percentage to cover administrative costs costs and default risk. (To his credit, Obama's plan included a lower market rate for low-income borrowers.)
Senate Democrats didn't take long to come around to the Republican position, putting together a “bipartisan compromise” designed to ensure the taxpayers' investment: Student loan interest rates would be reset each year based on the May auction of U.S. Treasuries, plus 1.8 percent—just low enough to please Democratic holdouts who had balked at a previous offer of 2.1 percent. Democrats secured another concession, too: a cap on interest rates that would prevent undergraduate borrowers from paying more than 8.25 percent.
But the agreement fell apart when the Congressional Budget Office reported that the plan would cost $22 billion over the next ten years. Many Republicans had insisted that the government make money off its loans, using students' interest payments to reduce the deficit.
After returning to the drawing board, negotiators reached a new agreement: They would raise the interest rate pegged to U.S. Treasury notes to 2.05 percent for subsidized and unsubsidized borrowers alike, enough to generate an estimated $715 million in new revenue. That’s in addition to the $184 billion that the federal government is already expected to profit off of student loans over the next 10 years.
The Senate is expected to pass the forthcoming bill in a floor vote early next week, and in the House thereafter.
Sympathetic lawmakers have long described the move to a variable interest rate system as a win-win, lowering most students' borrowing costs in the short-term and ensuring that the federal government never loses a dime on their education. But undergraduates taking out new loans only “win” in the narrowest of senses. Low-income borrowers will see their interest rates rise immediately, from the subsidized 3.4 percent rate they enjoyed last year to 3.86 percent in 2013.
And while other borrowers will likely see lower rates in the first few years, interest rates are expected to rise significantly over the next decade. According to the CBO's baseline, rates on 10-year Treasury notes are projected to nearly triple in the next five years, from 1.8 percent last May to 5.2 percent by 2018. (The actual interest rate for undergraduates in 2013 would be 9 basis points lower than the CBO estimate below.)
But interest rates could also rise much faster than the CBO predicts; that's one major disadvantage of tying students' borrowing costs to the volatility of the bond market. If 10-year Treasury yields were to rise to a level similar to what we saw during the 1990s, undergraduates could hit the 8.25 percent interest rate ceiling as early as 2017. For the average undergraduate borrower, that means paying about 25 percent more in interest over the life of their loan, or nearly $3,000. For a low-income borrower who would have paid 3.4 percent in 2011 or 2012, it's an increase of about 150 percent and over $9,000.
It is telling that one of the Republicans' primary demands throughout these student loan negotiations was the elimination of any preferential treatment for low-income borrowers. After all, banks don't give you a discount on a home mortgage or a personal loan if you come from a poor family or have few assets. In fact, they charge you substantially more. Low-income people are a risk to a bank's bottom line.
Republicans think the federal government should act more like a bank. And Democrats, for the most part, have capitulated.